When Peer Pressure Took the Hand of Greed

I once asked the chairman of Wells Fargo how his bank had gotten sucked into dubious Third World loans. “Greed,” he responded. “Just greed.”

He might have added another motive: peer pressure. We think of peer pressure as the force that gets kids into trouble, but business is as subject to it as teenagers are.

When a lot of states deregulated their electric utilities in the 1990s, these formerly conservative companies went on an international binge. They started buying up utilities around the world with a passion—a passion often fed by the fear that they were being left out of the great global bonanza. Some believed that they would not be able to hold up their heads at the meetings of the Edison Electric Institute unless they could discuss their latest acquisition in a faraway land. From Brazil to Indonesia, American electric utilities were into globalizing and loving it.

Of course, most of these investments went sour. The expected profits were as often as not consumed by currency variations, confiscatory local taxes and dishonest politicians, who sought to extract bribes from the operators as soon as the ink was dry on the contracts. Many American executives did not know anything about local conditions. For example they were unaware that in much of Latin America, and parts of Asia, up to 50 percent of the electricity is stolen. Governments are powerless to stop the theft for fear of social upheaval.

Helping the electric utilities make their mistakes were the investment banks. Mergers and acquisitions, are the mother’s milk of investment banking. The banks often found the deals, researched them and took them to the American companies. Their reward: giant fees.

One of these investment houses was the now bankrupt Lehman Brothers. At the height of the madness, as the publisher of The Energy Daily, I was invited to give a lecture to Lehman clients. The audience was half Lehman executives and half newly-minted internationalists. I told them the truth about investing in other people’s infrastructure: It looks good on paper, but it does not work in practice because you will be resented as an absentee landlord. Populist politicians will run against you.

On the face of it, this was not what they wanted to hear. They wanted wilder music and stronger drink. One major utility executive who was also something of a king-maker in the Democratic Party told me I did not know what I was talking about. He was invested in Pakistan, and thought it was a great place to do business,

Yet privately, the Lehman executives were glad I had called for a reality check. One managing director told me: “We should take their passports away.”

As investment after investment went south, many of the utility travelers came to wish they had stayed at home. Lehman, other investment banks and their lawyers knew better, but those lovely fees were irresistible.

The utility madness was not earth-shaking, but it was symptomatic of how investment banks regarded money itself as the client not the fee-payers.

About this time the world became aware that an obscure and arcane branch of finance, derivatives, was growing and attracting not financiers, but mathematicians and physicists to slice and dice away from prying regulators, troublesome politicians and curious journalists. The linkage between collateral and loans was obscured. A change in the regulations in 2004 enabled investment banks to borrow or leverage their assets by 30-to-1 when it had been 12-to-1. No worries. The market would discipline itself, said the players.

Mortgages were the new financial manna. You could package them and sell them around the world. But Wall Street was not satisfied with the volume of mortgages being written in the old-fashioned way and thousands of mortgage brokers started loosening the criteria, until there was really no threshold for getting a mortgage.

Now the party is over and the administration of George W. Bush, a conservative, is nationalizing a large chunk of the financial markets. He is also tying the hands of the next president, and there is still no transparency. The only thing that is clear is that the taxpayer will pay.

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